Stick to deficit reduction

Rapid economic growth has gifted the government with a tax bonanza this year. Direct tax revenue, in particular, has been running well ahead of Budget estimates. So the government should expect to report much more than the 19 per cent revenue buoyancy that it had postulated in the Budget last February. By some guesstimates, the gain should be an additional Rs 30,000 crore""or about 0.75 per cent of GDP. If there is control on the expenditure side of the Budget, as the finance minister has repeatedly promised, then the fiscal deficit for the year should be significantly lower than the 3.8 per cent of GDP proposed by Mr Chidambaram, and perhaps as low as 3 per cent.

If that were to come about, it would bring fiscal correction forward by an astonishing two years. However, interest payments on government debt may turn out to be more than had been assumed, as rates have climbed during the year; customs collections may have been affected in recent weeks by the drop in the price of oil from the high points reached mid-year; and the government has taken on a slew of off-balance sheet liabilities (in the form of oil subsidies) which will not show up in the Budget numbers but which are a fiscal burden nevertheless. Factoring in all this, the fiscal performance may be only slightly better than what had been proposed at the start of the year.

What should the government do in such a situation? Should it use the cushion to open the spending tap on ambitious programmes that seek to deliver employment, irrigation, power, roads, education and the like, all of which are badly needed? Or, recognising the limited efficacy of most of these programmes, should the government win brownie points with the tax-paying population by announcing tax reductions""as the Prime Minister and finance minister have hinted? Or should it do neither, and focus on reducing the deficit further?

The answer must be informed by the state of the economy. Fiscal spending should be counter-cyclical: the government should open the tap on spending when growth signals are weak, so as to 'pump-prime' the system into heightened activity; and it should close the tap when there is enough momentum, so that the government borrowing more (to spend more) does not drive up interest rates and thereby squeeze the private sector. Since the signals suggest that the economy is growing at or near full capacity, and that investment in fresh capacity too is going on apace, there is no need for the government to add fuel to the fire. In other words, it should let tax rates be in every field other than tariffs (which must be cut), and it should not allow runaway growth in expenditure. Doing this is not easy when the times are good, because an improved fiscal situation tempts governments to give money away and/or to spend more of it. But continued fiscal discipline would be well worth the effort.

For one thing, as Prof. TN Srinivasan of Yale has argued recently, the level of government debt is too high for comfort, and if there is a choice the government should minimise additional borrowing. For another, India's international credit rating would move up another notch or two if the fiscal situation continued to improve""and that would lower the cost of funds garnered overseas. And for a third, it would help to dampen inflationary fires""something which has become the government's primary economic concern. This should not rule out tax reform of the kind that the finance minister may have in mind (dropping rates to neutralise the impact of withdrawn tax concessions); what it should rule out is fiscal adventurism simply because this year's numbers look unexpectedly good.